DeFi and Impact Investing Must Work In Tandem to Build Sustainable Economies
Gabriela Chang writes that DeFi was made for impact investing, and the two forces must work in tandem to address sustainability.
By: Gabriela Chang •DeFi News
While global crises are never welcomed, they do tend to kick people to find solutions to crucial challenges.
After the 2008 financial crisis, for instance, interest in impact investing grew. The COVID-19 crisis has further demonstrated the need for cooperation through investing strategies that are driven by values and ethics as much as profit.
Since the pandemic began in early 2020, we’ve seen an increase in the number of companies building out dedicated ESG teams, according to the head of J.P. Morgan’s Development Finance Institution. And institutional investors are launching more impact-focused investment funds to fulfill the UN Sustainable Development Goals.
More than $715B of assets under management are now committed to impact investing. This is a paradigm shift that is reshaping the future of investing. That’s why there is a natural fit between impact investing and DeFi, which, of course, has not only upended the traditional order in finance. It’s also providing impact investors with a powerful tool to track performance.
DeFi has enabled anyone with the internet and a digital wallet to earn a passive income.
The idea behind impact investing is straightforward – you invest your money to spur positive changes in the environment, human rights, labor practices, and equality. The expectation is that you generate financial returns on your capital, or at least, your capital is returned.
But the true impact of impact investing is often questioned. Many investors believe that doing good is a trade-off between social and environmental return and risk-adjusted financial return.
As a result, social enterprises often face greater scrutiny, with investors analyzing the performance down to the last dollar.
That’s where DeFi comes in. Fuelled by innovative leaders, decentralized finance projects are already taking the efficiencies of impact investing to a new level.
DeFi Could be Our Most Powerful Ticket Out of Poverty
Last year, millions of people across the globe discovered how blockchain technology is lowering the barriers of access to wealth generation, helping people access finance in a way they never could in the past.
As NFTs became Collins Dictionary’s ‘word of the year’, amassing a total of $14.1B over the last year, up from $65 million the year before, artists across developing countries used NFTs to earn a full-time income. And play-to-earn games helped villagers break out of cycles of poverty. Meme coins turned teenagers into millionaires.
Beyond simply holding and trading, DeFi has enabled anyone with the internet and a digital wallet to earn a passive income – a wealth generation tool traditionally limited to those already with the privilege to own wealth, to earn yield, helping millions break free from financial bondage and access anti-inflationary assets.
This became a critical tool for survival in countries like Argentina or El Salvador suffering from a plummeting peso.
DeFi’s power of tokenomics and incentive economies introduced a new tool that is bringing in more people, and consequently more liquidity, into wealth-generation pools. By rewarding crypto holders for participating and staking within economic ecosystems, not only are people able to invest and see a company grow, they’re able to access additional yield for their participation in staking, with return rates not seen before in traditional finance.
Connecting DeFi With the Real World of Impact Investing
And in DeFi, the rates of return can be higher than traditional impact investing projects because you’re opening investment to a decentralized pool of investors where anyone can choose to lock up digital assets as a way to get APY.
This has become the perfect recipe for success with impact investing.
So how do we overcome the challenge of incentivizing more people to do good with their money? Do impact investing on the blockchain. With DeFi’s powerful tokenomics, investors no longer have to sacrifice either a) impact or b) financial rewards. They can achieve both.
The value in DeFi is that you can easily invest in a project that is doing good, and by staking the native token of the project, you’re bringing greater liquidity and returns to both the project and your own portfolio.
The tokenomic model of a blockchain infrastructure project or an L2 solution can exist in the same way as an impact investing project. Except, on the other end of the smart contract, there are real people and social enterprise projects on the supply chain.
We have the power to build fairer and more efficient systems for unbanked farmers around the world thanks to the power of DeFi, crowd-lending and building sustainable supply chains where the farmers are no longer the weakest link.
In our case, these farmers are in Mexico, Brazil, and Honduras. Crypto investors in this model have two options: they can either simply lend a stablecoin for a steady and modest return (yet still higher than most traditional banks) at 8% APY, or they can choose to stake the native token for higher yield by locking their funds in a pool of crowd-collateral.
Unbanked farmers have access to new financing tools, and are able to produce more volume and improve the quality of their crops.
Both options trigger capital to be provided for various agricultural projects to help smallholder farmers generate new business and income. The funds from lenders (also known as stakers or traders), lock assets in a crowd-lending smart contract until the agreed amount is achieved and then is automatically released to the account of the farmers’ cooperative. This also allows farmers to better plan and project their land works and expenses, rather than calculating as per how much they can manage to harvest and sell.
Finally, this has opened the door to the pioneering of ecosystems of mutual beneficial value that are connected to the real world. Unbanked farmers have access to new financing tools, and are able to produce more volume and improve the quality of their crops, while investors can see notable returns while contributing to socio-economic and environmental impact in small agricultural communities.
Buyers can access a stable market, with a product that is sustainable and fully trackable along the entire supply chain. Middlemen are removed so the smallholder farmers benefit from the final price of their crops, improving their living standard through their own productivity, becoming less exposed to pressure to sell their crops at lower prices to put food on the table for their families in time.
Lending capital comes with a risk. What happens if a farmer on the other side of the protocol can’t pay back their loan?
Going one Step Further: Can DeFi Eliminate Trade-offs and Risks?
Thanks to the power of blockchain technology, if a farmer defaults, crowd-collateral and liquidity pools in DeFi can significantly lower these risks. Collateral secures the payment to the lenders in cases of default. After testing this theory, we can safely say that in 100% of cases, lenders were fully compensated with their principal and interest.
How is this possible? Inspired by the Aave Protocol Safety Model, a compensation pool locks native tokens, and loan originators on the other side of the smart contract – in the real world – must stake their own contribution of the native token to act as collateral for their own loans. Stakers stake 100% of their collateral, so there is close to zero chance that lenders will be at loss.
In circumstances where a farmers defaults on a loan, sufficient tokens in the compensation system are sold to make up for the default to ensure lenders get their return on interest, starting with the Loan Originator’s stake, then its auditor’s stake, then the stakers community, and lastly, if those tokens were not enough, the compensation system reserve that consists of 50% of the total supply of native tokens.
DeFi Staking Pools
This is all made possible thanks to the power of crowd-collateral in the form of DeFi staking pools, which ensures there is always a sufficient quantity to compensate investors at any time. For 1.2 billion unbanked farmers in the world who lack cash or data to be eligible for credit scoring or don’t have assets that can be tokenized, this system becomes a ticket out of poverty.
The challenge to seeing impact investing ecosystems grow at a critical moment in history will simply be getting more people involved in DeFi. Educating people on the benefits of DeFi and getting more people involved will help this.
Incentive tokenomics are powerful new tools for creating change, and we will see more use cases of this surface in 2022. It allows people to be rewarded for their participation, both financially and socio-economically, as they contribute towards achieving the United Nations Sustainable Development Goals.
The pandemic has become a catalyst for change, shifting investors across the world into action, attempting to resolve some of the most challenging issues we face today. DeFi is not just a way for crypto pros to make gains. DeFi has become a lifeline for many, and we will see more liquidity pools and smart contracts connected to real-world projects.
For investors, we have an opportunity to be proud of our investments. The DeFi community is full of bright, empowered changemakers and we’re excited about the innovation coming from this space in 2022.